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Introduction

to
Supply Chain Dynamics

MIT Center for


Transportation & Logistics ctl.mit.edu
1
Lesson Objectives
Recap of courses to date
Knowledge level setting
Refresh of basic concepts
What happens when reality strikes!
Real-world challenges
Agenda for SC3x Course
Introduction to Supply Chain Complexity
What it is, why we care, and where it comes from
How to manage (mitigate or embrace) complexity

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Recap of SCx Courses to Date

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MicroMasters Credential in SCM
SC0x Supply Chain Analytics

SC1x Supply Chain Fundamentals

SC2x Supply Chain Design

SC3x Supply Chain Dynamics

SC4x Supply Chain Systems & Technology

Final Capstone Exam

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Key Concepts SC0x SC Analytics
Objective:
Be familiar with and comfortable using the core analytical methods
most common in supply chain management
Deterministic Methods
Classic optimization
Linear programming
Integer (and mixed integer) programming
Stochastic Methods
Probability distributions and models
Statistics (descriptive and inferential)
Discrete event simulation

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Key Concepts SC1x SC Fundamentals
Objective:
Understand the basic models and trade-offs involved in demand forecasting,
inventory management, and transportation planning.
Demand Forecasting
Time series (moving average, exponential smoothing, etc.)
Causal analysis (regression)
New product forecasting
Inventory Management
Deterministic (economic order quantity EOQ) vs. Stochastic (single period,
continuous/periodic review) demand models
Inventory types (safety, cycle, pipeline, etc.)
Performance metrics (cycle service level, item fill rate)
Transportation Planning
Mode choice (total landed cost)
Impact of lead time (mean and variability)

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Key Concepts SC2x SC Design
Objective:
Understand why and how to design the three primary flows of supply
chains: physical, financial, and information.
Physical Flow Design
Facility Location Models (continuous and discrete)
Network models (transportation, transshipment, network flow)
Financial Design
Translating supply chain actions into financial terms
Activity based costing
Working capital
Discounted Cash Flow Analysis
Information Flow Design
Working with suppliers: procurement, auctions, risk sharing
Coordinating manufacturing: production planning, BOM, MRP/DRP
Collaborating with customers: aggregate planning, S&OP, bullwhip

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MicroMasters Credential in SCM
SC0x Supply Chain Analytics

SC1x Supply Chain Fundamentals

SC2x Supply Chain Design

SC3x Supply Chain Dynamics

SC4x Supply Chain Systems & Technology

Final Capstone Exam

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When Reality Strikes

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Examples of Reality Striking Back
When the low cost solution is expensive!
ShopCo Transportation sourcing circa 2000
National truckload procurement event
circa 2000

post-2002

Lessons:
We are not living in a steady state world!
Need to take potential disruptions into
account!

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Examples of Reality Striking Back
When the right location isnt right!
Supply chain network design finds
optimal locations based on costs . . .

Lessons:
There is more to location than proximity.
Taxes, customs, and duties can often
outweigh supply chain costs!
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SC3x Outline Week 5 Global Supply Chain Mgmt I
Customs, Duties, Tariffs, etc.
Week 1 Supply Chains as Systems
International Transportation
Managing Complexity
System Dynamics
Week 6 Global Supply Chain Mgmt II
Currency, Exchange Rates, Transfer
Week 2 Supply Chain Processes
Pricing, etc.
Process Analysis
International manufacturing, Network
Process Mapping design, etc.

Week 3 Business Strategy Week 7 Risk & Resilience


Basic Strategy Frameworks Causes and Classification of
Supply Chain Strategy Alignment Disruptions
Responses and Preparation
Week 4 Mid-Term Exam
Week 8 Final Exam

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Supply Chain Complexity

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Supply Chain Complexity
There is a general consensus that . . .
supply chains are complex,
they are only getting more complex, and
complexity adds costs to a supply chain,
Therefore, we should look to mitigate or minimize
complexity.

However, perhaps we should understand exactly


what complexity is!

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Accounting Complexity
Product Complexity Customer Complexity
Small batch sizes Customized products
Long set-up times Short lead times
Unique components Unpredictable orders
Special tests/inspections Extensive technical support
Extensive material handling Extensive post-sales support
Special vendors Special tests or requirements

high
overcosted

volume traditional
costs

undercosted
low
low high
complexity

Source: Introduction to Activity-Based Costing, Robert S. Kaplan, Harvard Business


MIT Center for Transportation & Logistics School Publishing, July 5, 2001. (Product Number: 197076) 15
What is complexity?

I know it when I see it


Justice Potter Stewart, in Jacobellis v. Ohio
regarding possible obscenity in a movie.

US Supreme Court Justice Potter Stewart


1915 - 1985

By Robert S. Oakes [Public domain], via Wikimedia Commons


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What is complexity?
Complicated versus Complex
Two types of complexity (Singe 1990)
Detail Complexity:
Distinct number of processes or parts within the system
Dynamic Complexity:
Unpredictability of response of the system due to interactions

A system is complex if it is made up of a large


number of parts that interact in a non-simple way.

Herbert Simon 1962

Source: Bozarth et al, Impact of Supply Chain Complexity on manufacturing Plant


MIT Center for Transportation & Logistics Performance, JOM 2009. 17
Complexity Drivers

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What are the drivers of SC Complexity?
less complex

1. Numerousness
2. Variety/Diversity
3. Interconnections/Interactions
4. Opacity of Interactions
5. Dynamic Effects

more complex

Source: Mitchell, Complexity A Guided Tour Oxford Press 2009.


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Why do we care?
Complexity is not introduced for complexitys sake
Drivers of complexity = Drivers of profitability
Drivers of profitability
Increase revenue per unit
Increase the number of customers
Increase number of units sold
Decrease cost per unit

Implicit to every strategy or action intended to


improve profitability is a hidden cost of complexity!

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Profitability Drivers = Complexity Drivers

Revenue/Unit
Numerousness
# Customers
strategy Variety/Diversity
or action
# Units
Interactions
Cost/Unit

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Example: Introduce new packaging format

Revenue/Unit
Numerousness
# Customers
Variety/Diversity
# Units
Interactions
Cost/Unit

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Example: Open a joint DC for online and
traditional retail replenishment

Revenue/Unit
Numerousness
# Customers
Variety/Diversity
# Units
Interactions
Cost/Unit

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Where does complexity enter the supply chain?

Most complexity enters from the ends!

customers and market

research & source make deliver marketing


development & sales

Desire for unique Desire for a wide


solutions and diverse product
portfolio.

Adapted from Scheiter et al, How much does complexity really cost? A.T. Kearney 2007.
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Identifying where complexity lies
Map the complexity fingerprint
Identify the potential complexity drivers
Count total number used
Count number that account for 80% EBIT

Package Types
Technologies

Customers
Complexity Drivers

Brands
SKUs
Total Number 10 33 892 65 2,200
Number in 80% EBIT 2 17 197 41 214
Percentage 20% 52% 22 63% 10%
%

Adapted from Scheiter et al, How much does complexity really cost? A.T. Kearney 2007.
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Complexity Reduction at Novartis

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Complexity Example: Novartis
Novartis ~ 2010
Global healthcare company based in Basel Switzerland
Four Divisions: Pharmaceuticals, Sandoz, Vaccines & Diagnostics, and
Consumer Health
Annual Revenue ~ $50.6 billion
Pharmaceuticals Division (Pharma)
Annual Revenue of ~$30 billion with > 60,000 full time associates
32 production sites (Europe, North America, South America, and Asia)
140 country markets
~13,000 finished product SKUs
Complexity Reduction Initiative (2010)

Source: Leiter, Kevin, Assessing and Reducing Product Portfolio Complexity in the
MIT Center for Transportation & Logistics Pharmaceutical Industry, MIT Thesis 2011. 27
Complexity Example: Novartis
Underlying Complexity Drivers
Country Markets SKUs were generally country specific
Multiple dosage forms (film-coated tablets, pre-filled syringes, etc.) & strengths
Multiple pack sizes and formats
Regulatory requirements - Same product produced at two plants creates two
SKUs
Difficulty in retiring products some required by regulation others due to mergers
Need to reduce SKUs . . . but which ones?
Segmentation analysis (sales by SKU)
Managerial judgment call on strategic SKUs
100
Percentage of
Sales Value

50 Percentage of
65% 13% 6% 14% 2% Inventory
0
0 20 40 60 80 100
Percentage of SKUs

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Complexity Example: Novartis
Simultaneous Two Pronged Approach

100

Redundant Product Tail End Pruning


Percentage of

50
Sales Value

Rationalization
0
0 20 40 60 80 100
Percentage of SKUs

Redundant Product Rationalization Tail End Pruning


Focus on mid to large selling SKUs Focus on SKUs with lowest volume
No unique customer needs and profitability
Sales of removed SKUs should map Cannot be done blindly due to
100% to other existing products interconnectedness and other factors

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Complexity Example: Novartis
Step #1. Redundant Product Rationalization
Bottoms up approach 100

50

Identify redundant profits by product 0


0 20 40 60 80 100

Match true customer requirements and align to products

Identify
Create Document/
Assess and Monitor Key
Cross Set Revise
Existing Remove Performance
Functional Objectives Global
Portfolio Redundant Indicators
Team Reqts
SKUs

Repeat Bi-Annually
Notes & Comments
Reduced SKUs by 30% with no sales loss
Reduced number of SKUs led to better forecasting
Very resource intensive initiative
Required buy-in by heads of finance & marketing
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Complexity Example: Novartis
Step #2. Tail End Pruning
Top-down approach 100

50

Identify and remove lowest volume and 0


0 20 40 60 80 100

least profitable products

Define Define Identify Approve


Set
Objectives Evaluation Tail End Trimming
Baseline
and Goals Criteria Products Proposals

Repeat Annually

Notes & Comments


Devil is in the details and the tail always regenerates!
What level of detail makes sense? Measure by SKU by Brand by Drug . . .
Two approaches considered:
MILP when high quality data is available
Criteria Threshold when data is imperfect

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Complexity Example: Novartis
Results of Complexity Reduction Initiative (2010)
Approximately 1100 SKUs pruned
43 complete brands were pruned!
Inventory savings of $22 M

Learnings
Process requires senior support
from marketing and operations
It is not a single shot exercise
must be scheduled and repeated
Redundancy removal can lead to other benefits
These initiatives complement new product introduction processes

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Portfolio Rationalization
at Hewlett Packard

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Hewlett Packard circa 2008

More than a billion customers in 170 countries


Wide variety of product lines and SKUs
> 2,000 Laser Printers
>15,000 Server SKUs
> 8 million Laptop & Desktop configurations
Multiple sales channels with variety of order cycle times
Shorter overall product lifecycles
New products constantly introduced
Marketing decision based on marginal revenue improvement
Minimal supply chain input on costs

Source: Ward et al.: HP Transforms Product Portfolio Management with Operations


MIT Center for Transportation & Logistics Research Interfaces 40(1), pp. 1732, 2010 INFORMS 34
Portfolio Rationalization
Portfolio Rationalization Project
Focus on Personal Systems Group (PSG)
Configurable PC products
Low per SKU costs but high underlying costs
Orders must ship 100% complete
One component short kills the entire order
Leads to long and unpredictable Order Cycle Time (OCT)

Two Simultaneous Initiatives


1. New Product ROI Screening
keeping overly complex products out
2. Revenue Coverage Optimization
for pruning existing products

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New Product Introduction Process (Stage-Gate)

Gate 1 Gate 2 Gate 3 Gate 4 Gate 5

Stage 2
Stage 1 Stage 3 Stage 4 Stage 5 Stage 6
Scoping &
Discovery & Build Development Test &
Pre-
Idea Business Validate Commercialize
Technical
Generation Case
Evaluation

100 68 47 33 28 24
Forecast Forecast
Forecast Forecast Firm Forecast Forecast Unit
Market Market Sales Unit Unit Sales Sales By
Revenue Revenue Revenue Sales Location
Potential Potential Potential

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New Product Screening
Challenges
Both volume and variety are distinct cost drivers for new products
Traditional Activity Based Costing (ABC) approach ignores complexity
Approach
Create a Complexity-Adjusted Margin to use in new product decisions

Complexity ROI =
( Incremental Margin Variable Complexity Costs)
( Fixed Complexity Costs)
Variable Complexity Costs Fixed Complexity Costs
Low Volume of a SKU drives costs High SKU variety drives costs
Volume discounts for procurement Resource costs (R&D, testing, etc.)
Excess costs (obsolescence, storage, etc.) External cash outlays (tooling, etc.)
Shortage costs (expedite, lost sales, etc.) Indirect impacts (mfg switching, returns etc.)

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New Product Screening
Calculating Complexity Costs
Used regression and ABC analysis on history
Demand Variability = f(Demand Volume)
Probability of Returns = f(Number of SKUs offered)

Implementation
Formed cross functional team (SC, Finance, Mkt) to validate approach
Reach consensus on reasonable rather than exact cost models
Created user friendly tool to assess Complexity ROI for new products
Incorporated spreadsheet into New Product Screening Process

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Revenue Coverage Optimization
Challenges
Existing products may no longer be profitable, but examining
products in isolation misses dependencies and interrelationships
Approach
Create optimization tool that maximizes the value of the active portfolio by
pruning existing products based on two metrics
Order Coverage Percentage of a given set of past orders that could be completely
filled from the portfolio
Revenue (Margin) Coverage Revenue (margin) of its covered orders as a percentage
of the total revenue from the data set.
Answers the question: If I could only have 100 products, which should I choose?

100
Cumulative Percentage of

80 RCO
Revenue Covered

Heuristic (Revenue)
60

40

20

0
0 200 400 600 800 1000 1200
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Portfolio Rationalization Project Results
Hard benefits
Over $500 M saved since 2005
Product adoption rate improved from 18% to 85%
LaserJet SKU count reduced by 40% in 3 years (2006-9)
RCO eliminated 3,300 of 11,00 SKUs from HPs Business Critical
Systems division
Softer benefits
Shift from revenue to margin focused management
Higher customer satisfaction
Less confusion for sales and customers
Higher forecasting accuracy
Better organizational efficiency forcing different areas of the
organization to talk with common language

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Embracing Complexity?

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When should complexity be embraced?
Value Destroying
Does the cost of complexity outweigh the value?
Does it introduce greater confusion to the customer?

Value Creating
Is the cost of the complexity less than the increase in value to the
customer?
Does the added complexity provide potentials for flexibility?
Does the added complexity create a competitive advantage?

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Embracing Complexity?
What industry has:
Very small batch sizes,
Long set up times with very short
desired lead times,
Highly customized products (no two are
alike),
Unpredictable order frequency, and
Many many very small customers.

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Small Format Printing
Current industry (US)
~30,000 firms in the printing industry (NAICS 323)
Small job shops (~50% of firms have 4 employees)
Fragmented and serving local markets
Traditional process for business cards
Relatively high design costs & time
High switch over and set up costs between runs
Individual card runs requires high minimum orders
Rough printing costs
$10-$20 per thousand square inches (MSI)
Business cards are 2 x 3.5 so 500 cards 3.5 MSI =$35

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Embracing Complexity
Vistaprint (and Cimpress)
Founded in 1995 profitable in 2001 IPO 2005
On line small format printing for micro-businesses
Mass Customization Platform Custom
Complete online design & order Made

Unit Cost
Integrated Production Processes
Large scale, high speed plants
Software ties design to production
Automated sorting, aggregation, Mass
Mass
and organizing of jobs for gang run Customized Produced

Production Run Size

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Embracing Complexity
Mass customization leadership:
Build a competitive moat based on scale advantage
Also uses a "minefield of patents"
Initial patents filed in France in 2000
Over 100 patents worldwide
Example; VistaBridge - Patent 6,992,794

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Key Points from Lesson

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Key Points from Lesson
Real life challenges
Supply Chain Complexity
Drivers
Numerousness
Variety/Diversity
Interconnections/Interactions
Opacity of Interactions
Dynamic Effects
Reducing Complexity
SKU count is major driver focus on entry and exit
Cross functional team and repeatable process
Embracing Complexity
Competitive advantage if done right
Need to align supply chain and other functions to support

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Questions, Comments, Suggestions?
Use the Discussion!

Dexter & Wilson neither complex nor complicated


Yankee Golden Retriever Rescued Dog
MIT Center for (www.ygrr.org) caplice@mit.edu
Transportation & Logistics ctl.mit.edu
MIT Center for Transportation & Logistics